AN INVESTOR EXPECTATIONS STOCK PRICE PREDICTIVE MODEL USING CLOSED‐END FUND PREMIUMS

Abstract

A LARGE BODY of random walk literature has developed casting doubt upon the major analytical techniques used by stock practitioners.' The narrow version of the R.W. hypothesis states that changes in stock prices are independent, and rigorous testing has overwhelmingly supported the contention while simultaneously suggesting technical analysis is worthless.2 The broad R.W. version rests on the principle of an efficient market in which news events occur randomly and are discounted immediately to the extent that value analysis, when based upon public information, is unlikely to produce returns above those normally expected for the associated risk class.3 In light of the abundance of R.W. findings, a new approach to stock selection and/or timing is required if one is to produce superior returns, and in this vein the avenue for theoretical exploration is an examination of investor expectations as recently suggested by Keenan.4 Section II develops a theory of investor expectations. Section III introduces the theoretical behavior of closed-end fund premiums, while a closed-end fund investor expectations model is developed in Section IV. Section V shows the results of various tests of the model, and Section VI presents a summary and the implications of the tests.